Questions for QE
One more month, then it's make-your-mind-up time. Today, the Bank of England's policy-makers decided to leave everything as it was. It would have been a shock if they had done anything else.
But on 4 February, it will be a different story. Then, the committee members will have to decide whether to expand one more time the asset purchase programme fondly known as QE - or, as so many people expect, put it on pause. Crucially, they will also have to work out how they are going to explain it.
It's probably never been more important for the Bank of England to provide a lucid explanation of its actions - or more difficult.
We tend to focus on the gilt market piece of this. Clearly the MPC wants to avoid a big bond market sell-off in reaction to a pause in QE. If they indeed put the policy on hold, they will want to find a form of words that emphasises the conditional nature of the decision.
There may be no way to prevent City headlines proclaiming that QE is over. But you can expect them to do their best. Maybe they could have the statement bid "au revoir to QE, but not necessarily farewell". Then again, maybe not.
But, in my view, there's a much bigger problem with explaining the MPC's actions, which is that even if they all agree that a pause is the right way forward, they won't necessarily agree on why.
The "textbook" reason to pause would be that £200bn in asset purchases is enough. It may not be obvious right now, but that's just because the lead times are even more "long and variable" (in Milton Friedman's phrase) than usual.
On that view, putting even more cash into the economy could risk further distortion of the financial markets - and could even be counter-productive if it raises market fears of asset bubbles and/or excess inflation down the road, pushing up long-term interest rates as a result. All the MPC needs to is sit back and watch, as the fairly strong recovery forecast in their latest November Inflation Report takes place.
To repeat, this is the "textbook" reason to pause. MPC members refer to the same textbook when they give speeches explaining how QE has worked. David Miles ran through the litany, in passing, in a thought-provoking speech [91Kb PDF] about the future size of the UK banking system just before Christmas:
"Since QE began corporate bond spreads have fallen sharply; for both investment-grade and non-investment-grade bonds, to their lowest levels since September 2008. And since the beginning of the QE policy, the FTSE All-Share Index has increased by about 45%."
"Falling corporate bond spreads and rising stock prices have encouraged companies to raise funds in the capital markets. Cumulative corporate bond and equity issuance in 2009 has been much stronger than on average during 2003-2008."
Here endeth the lesson. But even if QE has achieved all of this, you can still view it as a deep disappointment.
David Miles goes on to mention that since the beginning of 2009, the British non-bank corporate sector has repaid £45.2bn in bank debt - more than the net £38.4bn that they have raised on the capital markets.
Monetarists like Roger Bootle, firm supporters of the policy, have been particularly dismayed that, nine months on, lending across the economy is still so weak. As he says in a note today:
"[T]here is still little evidence that the MPC's policy of quantitative easing (QE) is having the desired effect on money and credit. At its last meeting, the committee deemed the rate of broad money growth 'disappointing'. That's an understatement - the money multipliers have collapsed."
As I said, he's a fan of QE. He thinks that all this is a reason for the MPC to offer the economy another "shot in the arm" next month. The policy-makers may decide to follow his advice.
But, as I suggested in my pre-Christmas post, there will be some on the MPC who favour a pause, not because they are sure that the policy has worked, but because they think it quite possible that it will not.
I know that at least one member of the committee thinks that if £200bn hasn't worked, it's hard to believe that another 25 or 50 billion will make all the difference.
In that latest Inflation Report, the Bank was quite clear about the downside risks to the "central projection" for a decent recovery. True, the charts showed the single most likely outcome, in the Bank's view, was economic growth of more than 4% in 2011. But the mean - average - forecast was around 3%, because there was still so much in the recovery scenario that could go wrong.
And top of the list of things that could go wrong is that QE does not have the larger long-term effect on the economy that the textbook hopes for and fondly expects. The traditional channels for lending in our our post-crunch economy might simply be too bunged up for QE to turn things around.
In that same post, I said the Bank and the Treasury were quietly thinking about a Plan B. 4 February will not be the day for rolling it out. The textbook scenario could yet materialise.
As I've said, if they decide not to authorise further purchases of assets, they will want to explain that a pause in QE does not necessarily mean the end.
What they will not want to explain - in so many words - is that the end of the policy will not necessarily mean that it has worked.